by GF Ortmann · 2007 · Cited by 485 — This paper presents the principles of cooperation and briefly describes the history and development of agricultural cooperatives in developed and
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Agrekon, Vol 46, No 1 (March 2007) Ortmann & King 40 Agricultural Cooperatives I: Hi story, Theory and Problems GF Ortmann & RP King 1 Abstract This paper presents the principles of coop eration and briefly desc ribes the history and development of agricultural cooperatives in developed and less-developed countries, with particular emphasis on South Africa. A new Co operatives Act, based on international principles of cooperation, was promulgated in South Africa in August 2005. The theory of cooperatives, and ne w institutional econ omics theory (NIE) (including transaction cost economics, agency theory an d property rights theory) and its applicability to the cooperative organizat ional form, are also presented, as are the inherent problems of convention al cooperatives, namely free- rider, horizon, portfolio, control and influence cost problems caused by vaguely defined property rights. An analysis of the future of c ooperatives in general, based on a NIE approach, suggests a life cycle for cooperatives (formation, growth, reorganization or exit) as they adapt to a changing economic environment char acterized by tech nological change, industrialization of agricultu re and growing individualism. 1. Introduction The South African (SA) government is promoting the use of cooperatives as organizations that could help enhance the development of small-scale farmers and other communities in South Africa. In August 2005 a new Cooperatives Act (No.14 of 2005), based on international cooperativ e principles, was signed into law by the SA government. This Act sees a major role for cooperatives in promoting the economic and social deve lopment, fiin partic ular by creating employment, generating income, facili tating broad-based black economic empowerment and eradicating povertyfl (RSA, 2005b: 2). The government has committed itself to providing a supportiv e legal environment for cooperatives. Relatively little research has been done on agricultural cooperatives in South Africa during the last deca de; for example, since 2000 only three articles that refer directly to cooperatives have been published in Agrekon, the official journal of the Agricultural Economics Association of South Africa (AEASA). 1 Respectively, Professor of Agricultural Econ omics, School of Agricultural Sciences and Agribusiness, University of KwaZulu-Natal, Pi etermaritzburg, South Africa, and Professor and Head, Department of Applied Economics, University of Minnesota, St. Paul, Minnesota, USA.

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Agrekon, Vol 46, No 1 (March 2007) Ortmann & King 41The objective of this paper is to pr esent the history and theory of, and problems associated with, traditional agricultural cooperatives. This will provide policy makers in the SA national and provincial departments of agriculture, the extension service, no n-governmental organizations (NGOs) and other advisors with a deeper insigh t into the issues involved. Subsequent research will investigate the question whether conventional cooperatives, or other cooperative organizational forms, are the appropriate vehicle to help reduce transaction costs and facilitate access of small-scale farmers in South Africa to input and product markets th at could promote their development. The next section defines cooperatives and briefly deals with the principles, history and development of cooperativ es in developed and less-developed countries, with particular emphasis on South Africa. In section 3 the theory of cooperatives, with particular refe rence to the neo-classical and new institutional economics (NIE) approaches, will be presented. This will inform the developments that have occurred in the cooperative or ganizational form, the conversion of some co nventional cooperatives in to investor-oriented firms (IOFs) and the rise of ne w generation cooperatives. Section 4 emphasizes the problems inherent in conven tional cooperatives and is followed by an analysis of the future of agricultural cooperat ives. The paper ends with a discussion and some conclusions. 2. Definition, principles a nd history of cooperatives This section presents the definition an d unique principles of cooperatives relative to other (investor-oriented) firms. It also briefly co vers the history and development of agricultural cooperatives internationally and in South Africa. 2.1 Definition and princi ples of cooperatives The International Cooperative Alliance (ICA, 2005) defines a cooperative as fian autonomous association of person s united voluntarily to meet their common economic, social, and cultural needs and aspirations through a jointly-owned and democratically-controlled enterprisefl. The seven internationally recognized cooperative principles are: voluntary and open membership; democratic member contro l; member economic participation; autonomy and independence; provision of education, training and information; cooperation among cooperatives; and concern for the community. In 1987 the United States Department of Agriculture (USDA) adopted just the three principles of user ownership, user control and user benefit (roughly the first three ICA principles) following argu ments that cooperatives operating in global markets, particularly agricultur al marketing and supply cooperatives,

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Agrekon, Vol 46, No 1 (March 2007) Ortmann & King 42 cannot afford to internalize the ICA values and principles but must focus on fewer, more self-centred principles just to survive (Bircha ll, 2005). The other principles, it could be argued, are also held by other organizations. Essentially, then, a cooper ative is a user-owned and user-controlled business that distributes benefits equitably on the basis of use or patronage (Barton, 1989). Thus, a farmer member who a ccounts for 5% of the volume of agricultural products deliv ered to the cooperative wo uld receive 5% of the net earnings derived from the handling, processing and marketing of those products. fiSuch patronage dividends help boost the income of farmers directly or by reducing th e effective cost of the go ods and services providedfl (NCFC, 2005). This principle is often refe rred to as fibusiness-at-costfl (Barton, 1989). The United States (US) Nation al Cooperative Business Association (NCBA, 2005) also emphas izes the unique characteristics of cooperatives relative to other (investor-oriented) businesses: Cooperatives are owned and democr atically controlled by their members (i.e., those that use the cooper ative™s services or buy its goods) and not by outside investors. Members elect their board of directors from their ranks. Major policy deci sions are based on the one-member, one-vote principle, regardless of each member™s investment in the cooperative. Cooperatives return surplus inco me (revenue over expenses and investment) to members in proportion to their use or patronage of the cooperative, and not pr oportionate to their in vestment or ownership share. Cooperatives are motivated not by pr ofit, but by providing a service to satisfy members’ requirements for affordable and quality goods or services. Cooperatives exist solely to serve their members. Cooperatives pay taxes on income re tained for investment and reserves. Surplus revenues are returned, accord ing to patronage, to individual members who pay taxes on that income. Why are cooperatives being establishe d? The NCBA (2005) argues that cooperatives fiare formed by their me mbers when the marketplace fails to provide needed goods and services at affo rdable prices and acceptable quality. Cooperatives empower peop le to improve their qua lity of life and enhance their economic opportunities through self-helpfl. The NCFC (2005) echoes these sentiments by providing the foll owing reasons why c ooperatives were, or are being, formed: to strengthen ba rgaining power; maintain access to competitive markets; capitalize on new market opportunities; obtain needed products and services on a competitive basis; improve inco me opportunities;

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Agrekon, Vol 46, No 1 (March 2007) Ortmann & King 43reduce costs; and manage risk. Es sentially, then, farmers form(ed) cooperatives with the objective to gene rate greater profits, (1) by obtaining inputs and services at lower costs than they could obtain elsewhere or that were not available, and (2) by marketing their products at better prices or in markets that were previously not accessible (Barton, 2000). Many types of cooperatives have been established worldwide to serve the interests of members, including cons umer, producer, worker, and service cooperatives. According to the NCBA (2005), ther e are 48,000 cooperatives serving 120 million people in the US, whereas globally some 750,000 cooperatives serve 730 million memb ers. The various cooperative types provide members with diverse products and services, including financial services, equipment and farm supplies, marketing of agricultural products, consumer goods, utilities (e.g., electr icity, telephone), housing, and other services (e.g., insurance). Barton (2000) points out that, although cooperatives are common in many parts of the world, their most extensive and successful use during the last century has b een in North America and Europe. In general, agricultural cooperatives can be classified into three broad categories according to their main ac tivity, namely marketing cooperatives (which may bargain for better prices, ha ndle, process or manufacture, and sell farm products), farm supply cooperativ es (which may purchase in volume, manufacture, process or formulate, an d distribute farm supplies and inputs such as seed, fertilizer, feed, chemical s, petroleum products, farm equipment, hardware, and building supplies), and service cooperatives (which provide services such as trucking, storage, ginning, grinding, drying, artificial insemination, irrigation, cr edit, utilities, and insura nce) (Cropp & Ingalsbe, 1989; USDA, 2004). These c ooperatives usually vary greatly with regard to functions performed, and can also vary greatly in size. Most of the agricultural cooperatives are relatively small busi nesses. In 1999, fo r example, 50% of cooperatives in the US ha d less than $5 million in gross business volume and accounted for about 3% of total agricu ltural cooperative business, whereas 0.5% of cooperatives had a gross busine ss volume of $1 billion or more and accounted for 43% of total busi ness volume (Cropp, 2002). 2.2 History of agricultural cooperatives The modern cooperative originated in Europe and spread to other industrializing countries during the late 19 th century as a self-help method to counter extreme conditions of pove rty (Hoyt, 1989). However, one development that probably had the greatest singular impact on determining agricultural cooperatives™ unique operating principles was the formation in

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Agrekon, Vol 46, No 1 (March 2007) Ortmann & King 44 1844 of the Rochdale Society of Equitabl e Pioneers, Ltd. This was a consumer cooperative established in Rochdale , England, by a group of workers representing various trades who formul ated a set of basic operating rules based on a two-year stud y of cooperatives, includ ing some that were not successful. The cooperative™s objectives were to address members™ needs for better housing, employment, food, educ ation and other social requirements. Another important development regarding cooperatives servin g as credit or banking institutions was the establishment of the first savings and credit cooperative in 1864 by Fr iedrich Wilhelm Raiffeisen in Germany. The objective of the Raiffeisen Bank was to provide sa vings and credit serv ices in urban and rural areas based on the idea of fiself-hel pfl. Raiffeisen is ge nerally given credit for developing the rules that govern present-day credit unions (Ingalsbe & Groves, 1989). The development of cooperatives over ti me has been shaped by many factors and influences. Ingals be and Groves (1989) group these into three main types (all interrelated): (1) economic cond itions (caused by war, depression, technology, government ec onomic policy, etc.); (2) farmer organizations (including quality of thei r leadership, their motivation and enthusiasm to promote cooperatives, power to influence public policy, etc.); and (3) public policy (as determined by government interest, legislative initiative, and judicial interpretation). Since about 19 88 two phenomena have been occurring in the organization of agri cultural cooperatives in the US: (1) the restructuring and consolidation of conventional coop eratives and (2) the emergence of new generation cooperatives (NGCs) (Cook, 1995). NG Cs retain many of the characteristics of conventi onal cooperatives, but they focus on value-added activities. Member capital contributi ons are linked to product delivery (marketing) rights which attain value an d can be transferred, and membership is closed or restricted. These developmen ts suggest that coop erative strategies are becoming more offensive in na ture. Cropp (2002) contends that cooperatives in the US have mature d to become a sign ificant force in agriculture, and play an increasing role in influencing nati onal agricultural policies. In developing countries attempts to or ganize farmers into cooperatives have often failed, although cooperatives have the potential to supply farm inputs and market farm produc ts that are both impo rtant for agricultural development (Hoyt, 1989). The DTI (2003) provides a brief overview of cooperative development in African countries. Akwabi-Ameyaw (1997) suggests that in Africa fa rmer cooperatives have often failed because of problems in holding management acco untable to the members (i.e., moral hazard), leading to inappropriate political activities or financial irregularities

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Agrekon, Vol 46, No 1 (March 2007) Ortmann & King 45in management. Van Niekerk (1988) repo rts that cooperative failures in the former (less-developed) homelands of Sout h Africa were due ma inly to lack of management experience and knowledge, lack of capital resources, and disloyalty of members due to ignora nce. Some succes ses include food- processing cooperatives in Argentina an d Brazil, and cooperatives processing and marketing milk, sugar, and oil s eeds in India (Hoyt, 1989). ACDI/VOCA (2005) lists a number of successful coop erative ventures that they helped to establish in developing countries. Gove rnment policies regarding cooperatives are critical because they can constrai n or enhance independent cooperative development (Hoyt, 1989). The history of cooperative development in South Africa has been documented by several authors (e.g., Van Niek erk, 1988; DTI, 2003; Piesse et al ., 2003; RSA, 2005a). The first cooperative in South Africa was a cons umers™ cooperative that was established in 1892 under the Comp anies Act, as no cooperatives act existed at the time (Van Niekerk, 1988: 19). Several more cooperatives, particularly agricultural cooperatives , were registered under the Companies Act until 1908 when the first Cooperat ive Act was passed. This was followed by the Cooperative Societies Act of 1922 (Act No. 28 of 1922), which focused mainly on agricultural activities . Following recommendations by the Commission of Inquiry into Cooperatives and Agricultural Credit of 1934, the Cooperative Societies Act of 1939 (Act No. 29 of 1939), which still focused on agricultural activities, was passed by the SA Parliament . This Act, in turn, was repealed by the Cooperatives Act, 1981 (Act No. 91 of 1981), which also made provision for trading cooperatives. The 1981 Act wa s amended on at least eight occasions (RSA, 2005a). The present government did not consider the 1981 Act as a suitable vehicle for the development of cooperatives in the current era for various reasons (e.g., inadequate definition of a cooperativ e Œ registered cooperatives are not explicitly required to conform with co operative principles; presumption that the state play a highly interventionist or paternalistic role in relation to cooperatives; a focus primarily on ag ricultural cooperatives; provisions protecting members™ interests, particularly in regard to the board of directors, are poorly articulated; and onerous requ irements to register a cooperative) (RSA, 2005a). It thus init iated the process of develo ping a new Act based on international (ICA) principles. This pr ocess commenced with the publication of a draft Bill in 2000 an d a further revised draf t in 2003 for comment. Comments were received from a wide range of organizations, interest groups and individuals. The revised Bill culmin ated in the Cooperatives Act, 2005 (No.14 of 2005), which was published in the Government Gazette on August 18, 2005 (RSA, 2005b). A wide variety of pr imary cooperatives can register in

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Agrekon, Vol 46, No 1 (March 2007) Ortmann & King 47marketing and repeal of the Marketing Act of 1968 led to the Marketing of Agricultural Products Act, No. 47, of 1996, which ended state control of agricultural commodities and resulted in the demise of the marketing boards. With reforms of the financ ial sector happening conc urrently, subsidies were abolished in the 1990s. Thes e major policy reforms had a material effect on the role of cooperatives in So uth Africa. Cooperatives no longer have the privilege of being appointed as agents of variou s marketing boards, thus losing their regional monopoly powers , and are no longer involved in distributing government subsidies. Whil e they still provide short- and medium-term credit to farmers, they have to perform this function on a commercial basis as the Land Bank now also has to compete with commercial banks for this business. Several cooperatives have converted to IOFs and some are listed on the Johannesburg Securities Exchange (Piesse et al., 2003). In view of the history and development of cooperatives in South Africa and the political changes that have occu rred, the Cooperatives Act of 2005 recognizes: fithe co-operative values of self-hel p, self-reliance, self-responsibility, democracy, equality and social responsibility; that a viable, autonomous, self-relia nt and self-sustaining co-operative movement can play a major role in the economic an d social development of the Republic of South Africa, in pa rticular by creating employment, generating income, facili tating broad-based black economic empowerment and eradicating poverty; that the South African economy will benefit from increasing the number and variety of viable and sust ainable economic enterprises; that government is committed to prov iding a supportive legal environment to enable co-operatives to develop and flourishfl. The Act also aims to: fiensure that internationa l co-operative principles are recognised and implemented in the Repu blic of South Africa; enable co-operatives to register and acquire a legal status separate from their members; and facilitate the provision of targeted support for emerging co-operatives, particularly those owned by women and black peoplefl (RSA, 2005b: 2). The Department of Trade an d Industry (DTI), to whic h the administration of cooperatives was transferred from the National Department of Agriculture, has formulated a cooperative developmen t policy after a part icipatory process (DTI, 2004). This policy re cognizes cooperatives established under, and supported by, the previous (apartheid) government, but focuses on emerging

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Agrekon, Vol 46, No 1 (March 2007) Ortmann & King 48 cooperatives. The Cooperatives Bill (now Act) was drafted in line with this policy. A Cooperatives Deve lopment Unit has also been established within the DTI to enhance the development of coop eratives (e.g., by reviewing policies and strategies, coordinating government institutions and donor activities, and promoting the cooperative concept). The main role of the Registrar of Cooperatives is the registration and de registration of cooperatives and the legal supervision of the compliance of laws and regulation s by cooperatives. The Cooperatives Advisory Board, which represents the interests of cooperatives, is a statutory agency th at advises the Mini ster of Trade and Industry on cooperative related issues (RSA, 2 005b). Clearly, the SA government is committed to supportin g the development of cooperatives, particularly amongst previously disadv antaged communities. However, it has stressed that before it w ill target cooperatives for support measures, it will require assurance that the organizations concerned are genuine cooperatives and subscribe to cooperative (ICA) principles (RSA, 2005a). As far as agricultural coop eratives are concerned, Do yer (2005) feels that the agricultural sector has lost consider able intellectual and administrative capacity since the Registrar of Cooper atives moved to the DTI, which has adopted a centralization a pproach with only one department dealing with all cooperatives. However, he believes th at the new Act makes it easier than before to establish and operate a cooperative. Several large cooperatives in South Afri ca have converted to IOFs in recent years and there is still considerable co ntroversy in the agricultural community over the merits of cooperatives versus IOFs (AgriTV, 2003) . Essentially, the controversy revolves around the questi on of whether farmers™ interests are better served by remainin g members of a cooperativ e owned by them, or by an IOF that is managed and owned by shareholders. The arguments in favour of IOFs include their easier access to va rious sources of capital; their ability to attract top-quality management; the alig nment of shareholders™ interests with those of customers; and an entrepreneur ial flair often missing in cooperatives. Also, as cooperative members are often reluctant to fully capitalize their cooperative (because they do not receive a competitive return on their capital), it cannot provide top-quality service and match the competition from IOFs. Thus, cooperative members face the memb er/shareholder conf lict Œ they may receive a good service from their cooperative, but th e return on their capital invested is poor compared to what sh areholders in an IOF may receive on their investment in terms of dividends and the potential for capital growth. Proponents of cooperativ es argue that a cooperat ive exists to serve its members who are able to re tain influence over its functions and activities (AgriTV, 2003). Philip (200 3) supports the establishm ent of user cooperatives

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Agrekon, Vol 46, No 1 (March 2007) Ortmann & King 49in South Africa and argues that they can reduce costs, enhance incomes, and improve the viability of business activiti es; they thus have significant potential to contribute towards reducing po verty, enhancing empowerment, and creating jobs. At the end of 2004 there were 459 regist ered agricultural cooperatives in South Africa, while non-agricultural cooperat ives numbered 3,751 (Registrar of Cooperatives, as cited by Van der Walt, 2005). Al though there have been relatively large numbers of new cooper ative registrations over the last few years, Van der Walt (2005) maintains that it is difficult to ascertain how many of these are actually active and thriving . In a recent study of a sample of 54 registered cooperatives in Limpopo province (one of the economically poorer provinces in South Africa), Van der Walt (2005) found that 65% of these were not operational. Reasons provided include (in order of importance): poor management, lack of training, conflict among members, lack of funds, and operations never started after regist ration. Nearly 50 % of respondents admitted that the service provided to clients was inadeq uate, which could have caused conflict among members an d failure. Overall, poor management was indicated as the most important reason for cooperative failure. These issues are clearly important for gove rnment officials who are promoting cooperatives and for the communities who wish to establish cooperatives. Education and training of managers and members, and mentoring of managers (at least over the short- to me dium-term) appear to be critical, but not sufficient, requirements for the esta blishment and operation of successful cooperatives. In view of the history, development, pr oblems experienced, and the fact that several cooperatives in South Africa (and globally) have conv erted to IOFs, it is helpful to consider the theory of cooperatives and the new institutional economics approach to c ooperative organization in order to gain a deeper insight into the role of institutions in organizational design. 3. Theory of cooperatives and New Institutional Economics (NIE) 3.1 Theory of cooperatives Helmberger and Hoos (1962) can be re garded as having developed the first complete mathematical model of behavi our of an agricultural cooperative. Sexton (1995: 92), who provides a br ief overview of developments in the economic theory of cooper atives in the US prior to Helmberger and Hoos™ paper (see also LeVay, 1983; Sexton, 1984), considers their paper as fia landmark in the economic theory of cooperatives.fl Helmberger and Hoos

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Agrekon, Vol 46, No 1 (March 2007) Ortmann & King 50 (1962) use the neo-classical theory of the firm to de velop short-run and long- run models of a cooperative (including behavioural relations and positions of equilibrium for a cooperative and it s members under different sets of assumptions) using traditional margin al analysis. In their model, the cooperative™s optimization objective is to maximize benefits to members by maximizing fithe per unit value or average price by distributing all earnings back to members in proportion to thei r patronage volume or usefl (Torgerson et al ., 1998: 5). Sexton (1995) regards this filandmarkfl paper so highly because (1) the (correct) analysis of cooperativ e and member behaviour is based on a clear set of assumptions; (2) the mode l clearly distinguis hes between short- and long-run behaviour in a coop erative; and (3) based on these characteristics, the model set the stage for further advances in cooperative theory in the 1970s and 1980s. Torgerson et al . (1998) contend that Emelianoff (1942) made a major contribution to un derstanding the internal economics of cooperatives with his conception of th e cooperative as a form of vertical integration, and his focus on the structural and functional relationships of members (the principals) to their coop erative marketing organization (the agent). His model was later refined by Robotka (1947), Phillips (1953) and Aresvik (1955). There have been various debates on wh ether a cooperative enterprise should be treated as a firm (a decision-making entity), as Helmberger and Hoos (1962) did, or as an organizatio n (aggregation) of econom ic units (members), as treated by Emelianoff (1942), Robotka ( 1947), and Phillips ( 1953), for example. Rhodes (1995) presents an overview of the debate on the Helmberger-Hoos and Phillips models, with the former initially having the greatest support among economists, alth ough their contribution has also been criticized (e.g., LeVay, 1983; Lopez and Spre en, 1985; Sexton , 1986). Sexton (1995: 94) views this debate as fiprimarily one of se mantics,fl and considers the issue not important to understanding cooperat ives. He sees the development of alternative models as application of advances in economic theory of cooperatives reflecting fithe rich ness of the environments in which cooperatives operate and the need to ha ve alternative models that apply in different settingsfl (p. 97). Staatz (1994), Roye r (1994) and Torgerson et al . (1998) also contribute to this debate. Over the past few decades, the rapi dly changing economic environment, reflected in increasing globalization and agricultural industrialization, has led many agricultural cooperat ives to undertake substant ial structural changes in order to adapt to the new situation. Royer (1999), fo r example, mentions that in addition to mergers, consolidations and acquisitions (hor izontal and vertical restructuring), cooperatives have become increasingly involved in

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